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Back in January we discussed challenges involved when the risks of reverse factoring agreements are introduced. In 2020 the SEC issued comment letters to at least four companies, namely Procter & Gamble (PG), Graphic Packaging Holding (GPK), Boeing (BA) and Coca-Cola (CO) asking for more details about their reverse factoring agreements. This was after the SEC sent supply chain financing comment letters to Keurig Dr Pepper (KDP) and Masco (MAS) in 2019. In this blog, we would like to look at supply chain financing disclosures following the SEC reviews and discuss some of the language in the comment letters and disclosures that we find interesting.
First, let’s provide a quick recap. Reverse factoring agreements document the terms when a company helps a supplier sell the company’s accounts receivable in exchange for better credit terms. The supplier pays a fee to sell the receivables, and if the fee is small enough, the trade is a winner for all parties involved.
According to the 10-Q filing for the period June 30, 2020, Boeing’s trade payables included $4.4 billion payable to suppliers that participated in supply chain financing programs (SCF). Proctor & Gamble’s annual report disclosed that, as of June 30, 2020, the amounts due to suppliers that participated in SCF programs were about $4 billion. And Coca-Cola noted in their quarterly report that, as of June 30, 2020, suppliers elected to sell $714 million of the outstanding payment obligations.
A recent WSJ article used fees generated by banks that participated in reverse factoring agreements to estimate the size of the supply-chain financing sector. According to the article, the fees in the first half of 2020 were $12.7 billion, up 3.6% from the previous year. To develop a complete estimate of the size of the supply-chain financing receivables sold we would also need to know the average fees charged by the banks (the fee for each company would, of course, be different and depend on the credit risk of the receivables).
But what happens if a major shock changes the credit environment and the sources of short-term liquidity suddenly dry up?
The major challenges with understanding the risk involved in supply chain financing are lack of disclosure, diversity in practice, and a lack of regulatory guidance (we talked about that in our previous blog). In June 2020 the SEC issued an update on what companies are expected to disclose to address pandemic-related liquidity concerns. Notably, supply chain financing was explicitly referenced in this update:
“Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?”
The goal of the SEC comment letters process is to increase the transparency of financial reporting. For the most part, the SEC’s supply chain financing comments requested that the companies provide additional disclosures about the terms and materiality of the supply chain financing programs and their impact on liquidity and cash from operations. A recent Jim Hamilton’s blog (that we found on TheCorporateCounsel) described in great detail the nature of the supply chain comments issued so far, so we will skip the general discussion and look at language that sets the letters apart.
The opening letter for Coca Cola is provides an example of interesting language on the subject:
“We note from your disclosures that accounts payable increased roughly $1.1 billion in 2019 due to the extension of payment terms with your suppliers. We further note from external sources that it appears you have in place a supply chain finance program.” (emphasis added)
It is not uncommon for the SEC, as part of the comment letter process to review earnings calls, press releases, or media articles. A search of Audit Analytics’ comment letter database identified more than 800 companies which received a comment letter that was at least partially based on information disclosed during an earnings call. Yet, to the best of our knowledge, references to an “external source” are very rare. Disclosures about supply chain financing are limited, so it is not surprising that the SEC had to use a third-party source to confirm the existence of the agreements. It would be interesting to know if these external sources named other companies and whether more comment letters are coming. (We will keep monitoring the comment letter disclosures).
Finally, we would like to add a note about Boeing’s supply chain financing letters and relevant disclosures. A common theme among the supply chain financing comment letter responses was the lack of materiality of the supply chain financing on overall liquidity. Boeing noted in its response that the company does not consider supply chain financing programs to be material to the overall liquidity. The company pointed out that they had decided to provide additional disclosure because of the significant negative liquidity impact that the company has experienced. The disclosure below is from the 10-Q filing for the period June 30, 2020
“Payables to suppliers who elected to participate in supply chain financing programs declined by $1.3 billion for the six months ended June 30, 2020 and increased by $1.8 billion for the same period in the prior year. Supply chain financing is not material to our overall liquidity. The decline for the six months ended June 30, 2020 was primarily due to reductions in commercial purchases from suppliers and not due to any changes in the availability of supply chain financing. The increase for the six months ended June 30, 2019 reflects a combination of higher purchases, an extension of payment terms with certain suppliers and increased utilization of our supply chain financing programs.”
Boeing included additional disclosures in its 10-Q filing, noting that while the access to supply chain financing can suffer if the company’s credit rating is downgraded, the company does not expect that the changes in availability of supply chain financing to have a material effect on liquidity.
Based on the disclosure we have seen so far, companies tend to record supply chain financing in current liabilities, so extended payment terms following the supply chain programs may result in higher days payable. (For illustrative purposes, P&G disclosed that the company’s days payable increased 8 days as of the June 30, 2019.) The challenge, of course, is to understand whether the increase in accounts payable was part of the supply chain financing, a general change in the account payable’s terms, or just an attempt to delay payments and preserve liquidity.
In conclusion, receiving a comment letter does not imply that there is anything wrong with a company’s disclosures. The goal of a comment letter is to provide more information to investors, and we have seen increased disclosures of supply chain financing programs following the comment letter review process. For the companies that do not provide any supply chain financing disclosures (as we discussed above, a company may consider the program to be immaterial), investors can get a small hint by looking at the trends in accounts payable.
The Watchdog Blog Team contacted Coca-Cola, P&G, and Boeing concerning this article. Boeing and Coca-Cola declined to comment, and P&G did not respond to our request for comment.
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